Credit scores inform lenders about your borrowing history. There are several credit scoring companies, but the FICO Score is the one people refer to most often, notes Duke University. FICO Score calculations are based on five categories of information.
1. Payment History
Your payment history has a large impact on your credit score, myFICO explains. In fact, this record makes up 35 percent of your FICO Score. Payment history includes payments on credit cards, mortgages, and other loans. Late payments bring down a credit score and are especially serious if they happen multiple times, involve large amounts of money, or if they were made recently.
Your history of payments also considers foreclosures, bankruptcies, and any legal actions taken against you by creditors, such as suing you or placing a lien on your property. These events have a negative effect on a credit score. Ideally, your goal is to have zero foreclosures and as few late payments as possible in your history. The good news is that if you’ve had problems in the past, your score will gradually increase if you consistently make payments on time.
Your credit score is dependent on the amount of debt you currently owe, notes myFICO. With credit card debt, for example, credit scoring companies compare your balance to your credit line, or the total amount you’re allowed to borrow. The smaller your balance is in relation to that limit, the better your score is. Keep in mind that the balance used here is generally the balance found on your last statement. If that balance was high, it may affect your credit score even if you paid it off when you received your bill.
For loans where you borrow money up front and then pay if off with the same amount each month (for instance, an auto loan) the credit scorer looks at how much you owe now compared to how much you borrowed. Someone who has paid off 90 percent of an auto loan receives a better score than someone who has only paid off 10 percent of a loan.
3. Duration of Accounts
Credit scores are also affected by how long a person has had credit, according to myFICO. This includes how long ago you opened your first account and the average age of all your accounts. It’s better for your score if you have older accounts rather than newer accounts.
4. Recent Activity
Credit scorers will also look at how recently you’ve applied for new accounts. Opening an account occasionally won’t have much of an impact, but applying for several new accounts at the same time can bring your score down.
5. Credit Variety
As noted by myFICO, credit scoring companies will consider how many kinds of credit you’ve used, for example, a personal loan, two credit cards, and a mortgage, versus only one credit card. Although this isn’t as important as the other factors, a person who has successfully paid off multiple credit types will have a somewhat better score than a person who has experience with only one way of borrowing money.
Each of these five factors represent a different aspect of your financial history and track record of paying off debts on time. As long as you use credit responsibly and meet your financial obligations, your score will improve.